Sovereign International Daily Market Report
Dollar falters as soft US data dampens Fed rate hike bets
Summary:
The recent rally in the US dollar appears to be losing steam, with the greenback slumping to a two-week low against its major peers on Tuesday.
A report released from the Wall Street Journal last week that suggested Fed officials are considering slowing the pace of interest rate hikes from December has partly stopped the dollar in its tracks. Markets continue to believe that another 75 basis point rate hike from the Fed is a done deal at next week’s FOMC meeting, but the scale of tightening beyond then is more of an open question. A return to a smaller 50bp hike in December now appears to be the base case scenario, with fed fund futures now suggesting that the hike cycle could be done by February.
Some particularly soft macroeconomic data out of the US yesterday appear to have exacerbated the sell-off in the dollar, at the expense of just about everything else. The housing price index, which measures month on month changes in average prices of single-family houses, fell by another 0.7% in August (-0.3% expected) in a fresh sign that tighter monetary conditions are filtering through weaker demand for property. It also marks the first time since 2011 that the index has fallen for two consecutive months. To compound the misery, US consumer confidence fell to a three-month low, while the Richmond Fed manufacturing index sank to -10, its lowest level since the peak of the pandemic. All in all, just the kind of news that could persuade Fed members to take their foot off the pedal.
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Risk currencies were well supported throughout afternoon trading on Tuesday, notably those in Europe such as the Swedish krona, Polish zloty, and Norwegian krone. The euro lagged slightly behind some of its regional peers, although it still managed to edge back towards parity with the US dollar. A stronger-than-expected set of confidence indicators from IFO helped support the common currency, as have growing expectations that the European Central Bank could deliver a hawkish message at its policy meeting on Thursday. At the time of writing, markets are fully pricing in another 75bp hike from the ECB this week, but we think that investors are underestimating how high rates could go into 2023. Should the Governing Council acknowledge this on Thursday, then the euro could outperform during the remainder of the week.
In the UK, almost all news headlines have centred around the appointment of Rishi Sunak as next Tory leader and Prime Minister. While there was a sense of inevitability to the appointment, particularly after Boris Johnson pulled out of the leadership race over the weekend, UK assets appear to have been buoyed by the news. At 42 years old, Sunak is one of the youngest Prime Ministers to ever set foot in number 10, though markets still see him as a fairly steady pair of hands, particularly when it comes to stabilising the UK economy. Sunak’s leadership credentials are yet to really be tested, but investors seem to be of the view that his largely encouraging stint as chancellor should stand him in good stead. This has partly helped lift the pound back on the US dollar, and around its highest level since the mini-budget announcement.
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